Direct Physical Loss By Tenants Is Excluded Under Policy’s Dishonest or Criminal Acts Exclusion

Christina Phillips | Property Insurance Coverage Law Blog | October 2, 2018

Is loss or damage caused by a tenant covered under an all-risk insurance policy? Like most issues addressed in the Merlin blog posts, the answer is: it depends on the facts and the policy language.

The Sixth Circuit in KVG Properties, Inc. v. Westfield Ins. Co., 2018 WL 3978211 (6th Cir. Aug. 21, 2018) recently addressed this issue under a factual situation becoming more and more prevalent. Unbeknownst to KVG, it’s commercial tenants were growing marijuana in the property. Ultimately, the tenants were caught during a raid by the U.S. Drug Enforcement Agency. KVG immediately moved to evict the tenants and gain possession of the property. In its eviction proceedings KVG alleged that the tenants were “illegally growing marijuana.” The tenants were evicted and KVG obtained control of the property. However, the tenants had caused extensive damage to the property to accommodate their marijuana operations. The tenants had removed walls, changed duct work, cut holes in the roof, and severely damaged the HVAC systems. It was alleged the tenants had caused nearly $500,000 worth of damage.

KVG ultimately filed a claim against its insurer, Westfield. Westfield denied the claim based on the Dishonest or Criminal Acts Exclusion. In relevant part, the exclusion provides that Westfield will not pay for loss or damage caused by or resulting from any “[d]ishonest or criminal act by you, any of your partners, members, officers, managers employees (including leased employees), directors, trustees, authorized representatives or anyone to whom you entrust the property for any purpose.”1 Summary judgment was granted for Westfield. KVG appealed.

On appeal, the Sixth Circuit concluded that the property had sustained physical damage, caused by some risk (or risks) of direct physical loss. The Sixth Circuit then turned to whether the loss and damage was excluded as a result of the Dishonest or Criminal Acts Exclusion. The court focused its inquiry on the core question of whether the tenants committed a criminal act within the meaning of the policy. Dismissing KVG’s argument that Westfield could not invoke the exclusion unless the tenants had been convicted of a crime, the Sixth Circuit affirmed the lower court’s grant of summary judgment. It found there was no dispute that the tenants were engaged in illegal, criminal conduct. In that regard, the Sixth Circuit noted that KVG admitted as much in its eviction proceedings when it stated that the “tenant illegally grew marijuana.” The appellate court also noted that the raid by the DEA was part of a criminal investigation. As such, the Sixth Circuit concluded that Westfield had proven that the Dishonest or Criminal Acts Exclusion applied to bar coverage.
1 KVG did not argue and thus the Court did not address whether the exclusion should apply to someone who obtains “entrustment” by false pretenses.

Collecting For Immediate Remediation Costs

Paul LaSalle | Property Insurance Coverage Law Blog | October 7, 2018

Insurance policies ordinarily contain terms that provide that an insured must exhibit the damaged property for the insurance company’s inspection after a loss. The same policies also provide that an insured has a duty to mitigate damages to the property to prevent further damages. Does an insured breach the insurance policy by preventing the insurance company from assessing the full extent of damages if remediation work is performed at the property prior to the insurance company’s inspection?

The New Jersey Appellate Division recently addressed that scenario.1 In that case, two days after a fire, a public adjuster hired by the insured informed the insurance company of the fire and consequential property damage. Prior to the insurance company’s claim specialist’s inspection of the property to evaluate the property’s damages, he told the public adjuster to complete only minor repairs and work necessary to prevent further damage to the property, but not to perform remediation work. However, when the claim specialist inspected the property six days after the fire, he found that a remediation company hired by the property owner had completely gutted areas of the property to the wood-framing studs. Consequently, the insurance company asserted that it could not assess the extent of damage caused by the fire because of the limited inspection its claim specialist was able to conduct.

Unsatisfied that the amount the insurance company had paid was far less than the public adjuster’s estimated replacement value, the insured sued alleging breach of contract and demanded additional compensation for damage to the property. The trial court dismissed the suit finding that the insured failed to satisfy her evidentiary burden as to damages because she had remediation work done prior to the insurance company’s inspection.

Ultimately, the Appellate Division reversed the trial court and ruled that it was for the jury to determine the material dispute regarding the insurance company’s ability to determine the scope of the property’s fire damage and the amount of compensation that the insured was entitled to receive under the insurance policy.

This case illustrates the importance of fully documenting damages and preserving any damaged property until the insurer has had a chance to inspect.
1 Chen v. State Farm Fire & Cas. Co., No. A-2814-16T1, 2018 WL 3625108 (N.J. Super. Ct. App. Div. July 31, 2018).

Underlying Assertion of Negligent Misrepresentation Is Not Necessarily an Occurrence

Nora Valenza-Frost | PropertyCasualtyFocus | September 14, 2018


Courts sometimes struggle with the issue of whether property damage arising in the context of a contractual relationship, particularly in construction contracts, constitutes an “occurrence” under a standard commercial general liability (CGL) policy. Generally, but not always – and it varies from jurisdiction to jurisdiction – courts regard contractual breaches as non-accidental conduct, and/or apply the so-called “business risk” exclusions (such as the standard CGL “Your Work” exclusion), in finding no coverage. Lexington Ins. Co. v. Chicago Flameproof Wood Specialties Corp., No. 17-cv-3513 (N.D. Ill. Aug 10, 2018), a recent decision from a federal court in Illinois, is illustrative.

Lexington Insurance Company (“Lexington”) issued a CGL policy to Chicago Flameproof and Wood Specialties Corporation (“Chicago Flameproof”). The policy provided that Lexington would pay sums that Chicago Flameproof “becomes legally obligated to pay as damages because of bodily injury or property damage” that is “caused by an occurrence that takes place in the coverage territory” and that “occurs during the policy period.”

A framing contractor, required by contract to use fire-retardant-treated lumber meeting International Building Code (IBC) requirements, procured lumber from Chicago Flameproof to be used for the exterior walls of four buildings. The framing contractor contracted with Chicago Flameproof to buy D-Blaze lumber, but instead, was provided non-IBC-compliant lumber. As a result, the framing contractor was ultimately instructed to remove and replace the non-compliant lumber and sued Chicago Flameproof for negligently or fraudulently misrepresenting the type of lumber it was providing, resulting in damage to the exterior walls, wiring, and Tyvek insulation on the buildings, among other things (the “Underlying Actions”).

Chicago Flameproof sought coverage from Lexington, but Lexington challenged coverage and filed a declaratory judgment action, arguing that its duties to defend and indemnify were not triggered “because the claims against Chicago Flameproof do not involve property damage, were not the result of an occurrence, and were otherwise excluded by the policy’s business risk exclusions.” The parties moved for summary judgment, agreeing that no factual dispute existed and the only issue was the interpretation of the CGL policy, a question of law.

The court disagreed with Lexington’s argument that there was no “property damage” as the framing contractor sought to hold Chicago Flameproof “liable for physical injury to tangible property.” The court also disagreed with Lexington’s argument that the damage alleged was “nothing more than economic injuries stemming from the repair and replacement of the non-compliant lumber,” as there were “allegations of physical alterations to property other than the insured’s product” caused by the removal process which could fall within the definition of “property damage.”

However, the court acknowledged that, “for property damage to be covered by the CGL policy, it must be caused by an ‘occurrence.’” Illinois courts find an “occurrence” in the insurance context to mean:

An unforeseen occurrence, usually of an untoward or disastrous character or [a] … sudden, or unexpected event of an inflicting or unfortunate character…. However, even if the person performing the act did not intend or expect the result, if the result is the rational and probable consequence of the act, or, stated differently, the natural and ordinary consequence of the act, it is not an accident for liability insurance purposes.

Chicago Flameproof argued that the Underlying Actions satisfy the “occurrence” requirement “because they assert negligent misrepresentation and because Chicago Flameproof did not expect or intend the injuries to other building materials.” The court disagreed, and focused on the conduct alleged: Chicago Flameproof “failed to exercise reasonable care when it represented that it had D-Blaze lumber in stock and when it did not inform [the framing contractor] that its orders could be fulfilled.” Although couched in negligence terminology, the thrust of the complaints “is that Chicago Flameproof engaged in deliberate conduct – the shipping of the wrong lumber and the concealment of that fact – that caused the alleged property damage.”

The court reasoned that, even though Chicago Flameproof’s delivery of the lumber was allegedly intentional “does not necessarily mean that it expected or intended the collateral injuries to the exterior walls, wiring, and insulation…. Chicago Flameproof could have and should have reasonably anticipated that such injuries could result from supplying” the wrong lumber, which had to be torn out of the buildings. “These damages are the natural and ordinary consequence of knowingly supplying a non-compliant product and thus do not potentially fall within the CGL policy’s coverage.”

In concluding, the court stated that, although the Underlying Actions contain “one count for negligent misrepresentation, mere inclusion of a negligence theory does not – and cannot – by itself satisfy the occurrence requirement. Nowhere in the complaint are there allegations of an unforeseen or accidental event that produced property damage.”

This case is a helpful reminder that liability insurance cannot be used as a warranty for an insured’s failure to fulfill contractual undertakings, and that even if couched in a complaint as “negligent” conduct, when assessing an insurer’s duty to defend and indemnify under a CGL policy, careful consideration should be paid to the cause of the alleged damages when determining if there is an “occurrence.”

Wind, Flood or Storm Surge: Pick Your Peril Carefully

Geoffrey Greeves | It Pays to Be Covered | September 4, 2018

A catastrophic loss, such as a hurricane strike, can force any company out of business, even if it is insured. Although a business does not suffer any direct physical damage to its facilities, fickle natural disaster events can disrupt a company’s entire supply chain, with ripple effects for vendors, suppliers, customers and second-tier providers of services or goods.

With scorching August temperatures and the Atlantic hurricane season ramping up to full speed, the next months could, unfortunately, once again visit doom on vulnerable coastal areas, disrupting water or power services, causing evacuation and curfew orders, limiting travel, or halting operations either partially or fully. Securing insurance proceeds and FEMA assistance is crucial to business disaster recovery implementation.

1. What caused my loss?

A ubiquitous issue that arises with respect to natural disasters is how the peril is characterized – is it a hurricane, a “named storm,” a windstorm, a flood, or something else under your insurance policy? And what occasioned the particular damage at issue in the insurance claim – wind, wind-driven rain, storm surge, or flood?

How the mechanism of loss is characterized has critical implications for insurance recovery. Policies commonly provide different amounts of available limits (and sub-limits) for different types of losses (e.g., State Farm Florida Ins. Co. v. Moody, considering policy that limited coverage for damage caused by “hurricane” but that did not limit coverage for damage caused by “tornado”). And in some cases, policies may not provide coverage at all for losses that occurred as a result of certain causes (e.g., In re Katrina Canal Breaches Litig., considering whether damage to property was caused by flood or by the negligent design and construction of levees; flood being an excluded peril under the policy, while negligent construction was covered). For example, a commercial property insurance policy may provide coverage for damage caused by wind or a named storm but exclude coverage for damage caused by flood (e.g., Bradley v. Allstate Ins. Co.).  Complicating this analysis, policies often contain overlapping ill-defined concepts of “flood” vs. “named storm.” One may question whether a storm surge resulting from a named storm is treated as part of the named storm or as a flood.

The net effect is that the scope and amount of coverage can vary dramatically depending on how the cause of loss is characterized up front to the carrier at the proof of loss stage – a critical juncture that is rarely straightforward and that usually benefits from thoughtful legal analysis. To hold carriers to their promises of disaster recovery, policyholders need to have a thorough understanding of the coverage provided under their policies, the relevant case law, and the mechanism or mechanisms that caused their loss. Properly determining the peril at the time of claim submission can allow a policyholder to achieve the benefit of its bargain with its carrier.

2. What if there is no physical damage to my property?

Assuming no physical damage to your insured premises, how does a business function without electricity, telephone, email or water service? Utility service interruption coverage (if purchased) indemnifies, for example, against loss due to lack of incoming electricity affected by damage from a covered cause (fire or named storm) to property away from the insured’s premises — usually the utility generating station. This type of insurance is commonly referred to as “off-premises power coverage.” Service interruption coverage is not standard, or even common but a policy could be endorsed to cover any of the following:

  • Water services – pumping stations and water mains.
  • Communications services – property used to supply telephone, radio, microwave or television services. Includes communication transmission lines, coaxial cables and microwave relays.
  • Power services – electricity, gas and steam, utility generating plants, switching stations, substations, transformers, and transmission lines. Typically the policyholder must elect either to include or exclude overhead transmission lines.

The value of goods, including raw goods under refrigeration, is often challenged by the carrier when presented for coverage. The issue is further complicated in large scale operations by several commonly found exclusions that limit the inherent risks associated with perishables, including mechanical defect, failure to maintain systems and consequential losses.

3. What if my loss resulted from both covered and non-covered events?

Given that property policies may provide coverage only for certain causes of loss, or may provide different amounts of coverage depending on the cause of loss (e.g., named storm vs. flood), a debatable issue often involves the extent to which a loss is covered when it is caused concurrently or sequentially by both covered and non-covered perils.

Some courts apply an “efficient proximate cause” test, under which a dominant cause is determined and coverage hinges upon whether that cause is covered, or alternatively whether the covered cause set the chain of events in motion. Other courts apply one of two “concurrent cause” analyses: (1) Some courts have ruled that when two causes combine to produce an indivisible loss, there is coverage as long as one of the causes was a covered peril under the policy, and (2) other courts have ruled that the policyholder bears the burden of differentiating damage attributable to covered and non-covered causes, and if the policyholder cannot meet that burden there is no coverage.

This analysis turns on the policy language as well. Insurers have sought to eliminate coverage in instances involving concurrent causes by incorporating “anti-concurrent causation” language in their policies that purports to bar coverage when an uncovered cause is involved in any way, whether directly or indirectly. For example, the policy may state: “We will not pay for loss or damage caused directly or indirectly by any of the following. Such loss or damage is excluded regardless of any other cause or event that contributes concurrently or in any sequence to the loss.” Some courts have enforced these anti-concurrent cause provisions while others have held that they are unenforceable, predominantly on public policy grounds. Where and how this language appears in the policy is also important and factors into how a court will view it. If the language is buried deep in a definition or an exclusion, for example, the situation might be distinguishable from existing case law.

For this reason it is important to review your endorsements at the time coverage is bound as well as analyze the policy exclusions that may be applicable to any loss to determine whether they are subject to anti-concurrent causation language.

4. How is storm surge different than wind?

After a catastrophic weather event in coastal areas, insurers and insureds frequently litigate whether property damage was caused by wind, on the one hand, or storm surge, on the other. Such litigation arises because property policies often cover damage caused by wind, while excluding coverage for damage caused by flood.

Courts considering such claims tend to characterize the peril of wind and the peril of storm surge separately. Courts have noted that storm surge is “little more than a synonym for a ‘tidal wave’ or wind-driven flood” and have held that damage from storm surge falls squarely within the bounds of flood exclusions, even where the flood exclusions do not expressly include the term “storm surge.” See, e.g., Leonard v. Nationwide Mut. Ins. Co.Tuepker v. State Farm Fire & Cas. Co.; or Bilbe v. Belsom (“We have repeatedly held that the term ‘flood’ includes storm surges.”). By contrast, property policies generally cover damage caused solely by wind (i.e., wind that doesn’t interact with water). See e.g., LeonardTuepker v. State Farm Fire & Cas. Co.; or State Farm Florida Ins. Co. v. Moody (determining that insureds were not entitled to recover because hurricane spawned the tornado that caused the damage and hurricane sublimit applied).

Recovery may rise or fall based on whether the property damage at issue resulted from wind alone (for example, a structure was blown over by wind) or whether the damage resulted from storm surge (i.e., flooding caused by wind). Insureds who buy a master property policy are wise to keep the distinction between wind and storm surge—and the impact of such distinction—top of mind when considering coverage issues post-hurricane. Legal analysis of the wording of any coverage grants or exclusions and choosing a peril wisely must become part of the recovery planning implementation strategy businesses rely on to maximize the insurance claim.

What Constitutes an “Abrupt Collapse”?

Edward Eshoo | Property Insurance Coverage Law Blog | September 3, 2018

Most property insurance policies provide additional coverage for direct physical loss of or damage to covered property caused by or resulting from an “abrupt collapse.”1 In Hoban v. Nova Casualty Company,2 a California federal district court recently addressed the meaning of the phrase “abrupt collapse,” which the commercial insurance policy at issue defined as “an abrupt falling down or caving in of a building or any part of a building with the result that the building or part of the building cannot be occupied for its intended purpose.”3

There, two roof trusses that supported the roof of a bowling alley failed. The truss failures caused the building ceiling, overhead monitors, and disco ball to drop approximately six to ten inches, and also caused ceiling tiles and a layer of insulation to fall to the tabletops and counters below. As a result of the truss failures, the ceiling fell to a height lower than it was originally constructed. Additionally, the truss failures caused damages to at least one of the building’s exterior walls. A County Building Inspector inspected the damage to the bowling alley on the same day the trusses failed, and immediately ordered the business closed for public safety reasons until the necessary repairs could be completed. The insureds then hired a general contractor to shore up the roof support system and to prevent a complete collapse. Following the shoring, the insureds were able to re-open the bowling alley to the public. The insurer eventually denied the claim, taking the position there was no collapse because the ceiling and the roof of the building had not fallen down to the ground.

After suit was filed, both parties moved for summary judgment on the issue whether the building had sustained an “abrupt collapse” within the meaning of the insurance policy. The insurer argued this language requires a building or a part of a building to completely fall to the ground. The insureds asserted this language allows for a partial collapse of a part of a building that renders the building unusable, even if the building or that part had not fallen completely to the ground.

The district court concluded that the phrase “abrupt collapse” was ambiguous because there was more than one reasonable interpretation of its intended meaning. The district court reasoned that nothing in the policy unambiguously informed the insureds that the building or a part thereof must fall completely to the ground to be covered. The term used by the policy was “abrupt collapse,” which the district court stated highlights the manner in which the collapse must occur to warrant coverage. The policy did not use the term “complete collapse,” which the district court noted would more readily refer to the degree of collapse. That coverage applies to the “abrupt” collapse of either “a building” or “any part of a building” strongly suggested to the district court that the policy was intended to cover a partial collapse of parts of the building, so long as it occurred abruptly, not only total or complete collapse. Moreover, according to the district court, specifying that the collapse must render the building or part of the building so it “cannot be occupied for its intended purpose” would be unnecessary and redundant if the policy required the building or part of the building to have collapsed to the ground. A building or part of a building that has collapsed to the ground cannot be occupied for any purpose, let alone for its intended purpose, and contracts are usually interpreted to avoid redundancy. The district court concluded that no language in the policy unambiguously required a building or a part of the building to fall to the ground for coverage to apply, as the insurer argued.

Interpreting this ambiguity in favor of the insureds, the district court found there was no genuine dispute of material fact as to whether a part of the building fell down and whether the building could be occupied for its intended purpose. It was undisputed that the overhead monitors, the disco ball, and the entire ceiling of the building fell six to ten inches. It also was undisputed that ceiling tiles and insulation fell to the tabletops and counters below. These events constituted “any part of a building” that has “fall[en] down.” Finally, it was undisputed that the business was closed for public safety reasons until repairs could be completed, and thus neither the building nor any part of it could be occupied for its intended purpose.4

The district court’s ruling in Hoban is consistent with the result reached by other courts who have likewise concluded that the phrase “abrupt collapse” is ambiguous as to whether there must be a complete and total falling down of a building or any part, thus resulting in an interpretation favorable to the insured.5 In each case, the court found that a part of a building (roof, trusses, support columns, ceiling, flooring) that deflected, buckled, dropped, or was displaced downward anywhere from one (1) inch to seventeen (17) inches such that the building or a part of it could not be occupied constituted an “abrupt collapse.”6
1 See ISO Form CP 10 30 10 12 and ISO Form HO 00 03 05 11.
2 Hoban v. Nova Cas. Co., 2018 WL 3954737 (E.D. Cal. August 15, 2018).
3 Hoban, 2018 WL 3954737, *2.
4 The policy in Hoban defined “abrupt collapse” the same way it is defined in ISO Form CP 10 30 10 12.
5 Seee.g.Ken Johnson Properties, LLC v. Harleysville Worcester Summary Ins. Co., 2013 WL 5487444 (D. Minn. Sept. 30, 2013); Kings Ridge Cmty. Ass’n., Inc. v. Sagamore Ins. Co., 98 So.3d 74 (Fla. DCA 2012); Scorpio v. Underwriters at Lloyd’s, London, 2012 WL 2020168 (D. R.I. June 5, 2012); Gullino v. Economy Fire and Cas. Co., 2012 IL App (1st) 102429 (Ill. App 2012); Landmark Realty, Inc. v. Great Am. Ins. Co., 2010 WL 5055805 (D. Md. Dec. 3, 2010); Malbco Holdings, LLC v. AMCO Ins. Co., 629 F.Supp.2d 1185 (D. Or. 2009).
6 To trigger coverage under both ISO Form CP 10 30 10 12 and ISO Form HO 00 03 05 11, the abrupt collapse must be caused by one or more of certain perils, including decay that is hidden from view. In Hoban, the abrupt collapse was caused in part by hidden decay.